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The Law of Diminishing Returns

Jamie Liddell

6 Mar 2017

Of the many laws that affect the international outsourcing space, one of the most important must be that of diminishing returns. At its heart outsourcing is about efficiency – a provider can only offer a decent value proposition, and turn a profit, if it can achieve a desired output more efficiently than can a would-be buyer of its services – and yet there’s only so much money in the hypothetical pot to invest in driving efficiencies: as a very basic example, if one can spend $x to achieve 10% savings, by the fifth investment of $x the savings made are only around 60% of what was achieved with the first tranche. The returns diminish. After a while, it becomes less and less worthwhile to invest $x in that project, when the same amount put into another deal can yield significantly more.

Finding the right balance between investment and returns (and knowing where is the line beyond which further investment will yield returns too paltry to justify) is vital in any business, but especially one as efficiency-based as outsourcing, where relationships have historically often featured buyers demanding constant and consistent efficiency gains and savings – and, moreover, where the necessary investments in technology and people can be gigantic. Hence the desire on the part of providers to share the value gained by any given investment across as many clients as possible – and the complications resulting from buy-side demands for bespoke work and customisation without a simultaneous understanding of why this of necessity means higher costs, which need to be passed on somewhere, somehow…

However, to a certain extent and in certain areas this is changing – indeed, has already changed. Writing recently for Outsource in an article entitled ‘Contracting for emerging technologies: change with the changes’, Megan Paul of law firm Mayer Brown examines how recent technological advances and trends (especially including cloud computing, and looking ahead to a new wave of automation and AI solutions) are impacting the way outsourcing agreements are framed and operated: "New emerging technologies, at this point, are relatively inflexible... Under the more traditional model, customers argued to shift risk on to the supplier because the supplier was the 'expert' and the customer was in a position to enter into a very bespoke arrangement – but this is not the case with emerging technology services. Instead customers are buying more standardised services..."

In a conversation following the publication of that article, another of my contributors opined that these developments were “breaking the law of diminishing returns” – yet I think, rather, that they’re in response to, and greatly respectful of, that law: by standardising services and prices, providers are limiting the scope on both sides of the agreement for “investment creep” which inevitably leads to diminishing returns. Of course, this also places hard limits on the efficiencies that can be gained, but amongst other benefits there’s actually a psychological value to this which I don’t think should be underestimated: knowing that there’s simply nothing to be gained by demanding new gains from a staunchly inflexible provider, buyers won’t be lured into paying for inexorably shrinking benefits (or persuading their provider to pay for it, typically resulting in a worsening of the relationship) – effectively, there’s much less incentive to waste resources on eventually fruitless development.

On the other hand… Providers still prepared to gamble that they can get worthwhile margins in that grey space between standardisation and customisation – in other words, betting that they can hold to the fine line beyond which return diminish down the plughole – might well come up trumps. Elsewhere on the Outsource site recently, Bhupender Singh, the CEO of Intelenet Global Services, writes that the “explosion of as-a-Service offerings will also continue to transform the sector moving through 2017. The growth of this type of product is down to BPO firms seeking to package their services as a tailored offering with value-added and ‘on demand’ delivery. In a very crowded marketplace, being able to create a bespoke product for a client could be a major differentiator and thus a great way to stand out from the crowd.” Standing out from the crowd, of course, flies in the face of another law of nature – that there’s safety in numbers – but in an age when differentiation is becoming more important by the day, perhaps taking on the law of diminishing returns full-frontal could make the difference between being gobbled up and becoming the one that gets away…

Jamie Liddell, Editor, Outsource

Jamie Liddell is the Editor-in-Chief of Outsource. He is a journalist with extensive B2B and consumer experience, particularly in the sourcing and international property sectors. A graduate of Cambridge University, Jamie worked as Chief Foreign Correspondent for property media company Blendon Communications before moving into full-time B2B journalism as launch editor of the Shared Services & Outsourcing Network. He took over the helm of the Outsource brand in April 2010 and has since overseen its transformation and evolution into the world's leading publication focusing on the sourcing, outsourcing and business transformation space.